says, an exchange rate is the price of one currency
in terms of another. And like all price
s in a free market
the exchange rate
can be explained by supply and demand
The main determinate of exchange rate is actually the interest rate. If the British interest rate rises, then there will be a flow of hot money into the country by international speculators. This is an increase in demand in Sterling and therefore leads to the price of the Pound rising in terms of others - an appreciation (or strengthening) of the Pound. Equally, if the interest rate falls there will be a fall in demand, depreciating the currency.
The main implication of a change in exchange rates is that the prices of exports and imports change. If the Pound were to strengthen, then it would cost more Euros per Pound. Therefore, if the price of a good were to stay the same (in monetary terms) in the UK it would cost more in Euros, raising the relative price of UK exports. Likewise, a Pound would buy more Euros, making imports into Britain cheaper for the British. This will result in British industry becoming less competative in all markets.